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State of California

Comprehensive Annual Financial Report

For the Fiscal Year Ended June 30, 2017

STATE OF CALIFORNIA

COMPREHENSIVE ANNUAL

FINANCIAL REPORT

For the Fiscal Year Ended June 30, 2017

Prepared by The Office of the State Controller

BETTY T. YEE California State Controller

Contents INTRODUCTORY SECTION

California State Controller’s Transmittal Letter....................................................................... iii Certificate of Achievement for Excellence in Financial Reporting ......................................... ix Principal Officials of the State of California............................................................................ x Organization Chart of the State of California .......................................................................... xi

FINANCIAL SECTION Independent Auditor’s Report .................................................................................................. 2 Management’s Discussion and Analysis .................................................................................. 5

BASIC FINANCIAL STATEMENTS GOVERNMENT-WIDE FINANCIAL STATEMENTS

Statement of Net Position................................................................................................ 32 Statement of Activities .................................................................................................... 36 FUND FINANCIAL STATEMENTS

Balance Sheet – Governmental Funds ............................................................................ 40 Reconciliation of the Governmental Funds Balance Sheet to

the Statement of Net Position................................................................................. 42 Statement of Revenues, Expenditures, and Changes in Fund Balances –

Governmental Funds .............................................................................................. 44 Reconciliation of the Statement of Revenues, Expenditures, and Changes in

Fund Balances of Governmental Funds to the Statement of Activities.................. 46 Statement of Net Position – Proprietary Funds............................................................... 48 Statement of Revenues, Expenses, and Changes in Fund Net Position –

Proprietary Funds ................................................................................................... 52 Statement of Cash Flows – Proprietary Funds ................................................................ 54 Statement of Fiduciary Net Position – Fiduciary Funds and

Similar Component Units....................................................................................... 58 Statement of Changes in Fiduciary Net Position – Fiduciary Funds and

Similar Component Units....................................................................................... 59 DISCRETELY PRESENTED COMPONENT UNITS FINANCIAL STATEMENTS Statement of Net Position – Discretely Presented Component Units –

Enterprise Activity.................................................................................................. 62 Statement of Activities – Discretely Presented Component Units –

Enterprise Activity.................................................................................................. 64 NOTES TO THE FINANCIAL STATEMENTS

Notes to the Financial Statements – Index ...................................................................... 65 Notes to the Financial Statements ................................................................................... 69

State of California Comprehensive Annual Financial Report

REQUIRED SUPPLEMENTARY INFORMATION Schedule of Changes in Net Pension Liability and Related Ratios – PERF and

Single-Employer Plans........................................................................................... 164 Schedule of State Pension Contributions – PERF and Single-Employer Plans.............. 172 Schedule of the State’s Proportionate Share of Net Pension Liability – CalSTRS......... 175 Schedule of the State’s Contributions – CalSTRS .......................................................... 175 Schedule of Funding Progress – Other Postemployment Benefit Plans ......................... 176 Infrastructure Assets Using the Modified Approach....................................................... 176 Budgetary Comparison Schedule – General Fund and Major Special

Revenue Funds ....................................................................................................... 182 Reconciliation of Budgetary Basis Fund Balances of the General Fund and

Major Special Revenue Funds to GAAP Basis Fund Balances ............................. 185 Notes to the Required Supplementary Information......................................................... 185

COMBINING FINANCIAL STATEMENTS AND SCHEDULES – NONMAJOR AND OTHER FUNDS Nonmajor Governmental Funds .................................................................................. 191 Combining Balance Sheet ............................................................................................... 194 Combining Statement of Revenues, Expenditures, and Changes in Fund Balances....... 198 Budgetary Comparison Schedule – Nonmajor Governmental Funds ............................. 202 Internal Service Funds.................................................................................................. 203 Combining Statement of Net Position............................................................................. 204 Combining Statement of Revenues, Expenses, and Changes in Fund Net Position ....... 208 Combining Statement of Cash Flows.............................................................................. 210 Nonmajor Enterprise Funds ........................................................................................ 215 Combining Statement of Net Position............................................................................. 216 Combining Statement of Revenues, Expenses, and Changes in Fund Net Position ....... 218 Combining Statement of Cash Flows.............................................................................. 219 Private Purpose Trust Funds........................................................................................ 221 Combining Statement of Fiduciary Net Position ............................................................ 222 Combining Statement of Changes in Fiduciary Net Position ......................................... 223 Fiduciary Funds and Similar Component Units – Pension and Other

Employee Benefit Trust Funds ............................................................................ 225 Combining Statement of Fiduciary Net Position ............................................................ 228 Combining Statement of Changes in Fiduciary Net Position ......................................... 230 Agency Funds ................................................................................................................ 233 Combining Statement of Fiduciary Assets and Liabilities.............................................. 234 Combining Statement of Changes in Fiduciary Assets and Liabilities ........................... 236 Nonmajor Component Units ........................................................................................ 239 Combining Statement of Net Position............................................................................. 240 Combining Statement of Activities ................................................................................. 244

Contents

STATISTICAL SECTION Financial Trends ............................................................................................................ 249 Schedule of Net Position by Component ........................................................................ 250 Schedule of Changes in Net Position .............................................................................. 252 Schedule of Fund Balances – Governmental Funds........................................................ 256 Schedule of Changes in Fund Balances – Governmental Funds..................................... 258 Revenue Capacity .......................................................................................................... 261 Schedule of Revenue Base .............................................................................................. 262 Schedule of Revenue Payers by Income Level/Industry................................................. 266 Schedule of Personal Income Tax Rates ......................................................................... 268 Debt Capacity ................................................................................................................ 271 Schedule of Ratios of Outstanding Debt by Type ........................................................... 272 Schedule of Ratios of General Bonded Debt Outstanding.............................................. 274 Schedule of General Obligation Bonds Outstanding ...................................................... 276 Schedule of Pledged Revenue Coverage......................................................................... 277 Demographic and Economic Information................................................................... 281 Schedule of Demographic and Economic Indicators ...................................................... 282 Schedule of Employment by Industry............................................................................. 284 Operating Information ................................................................................................. 285 Schedule of Full-time Equivalent State Employees by Function.................................... 286 Schedule of Operating Indicators by Function................................................................ 288 Schedule of Capital Asset Statistics by Function............................................................ 292

Acknowledgments.................................................................................................................... 296


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Introductory Section

BETTY T. YEE California State Controller

March 21, 2018

To the Citizens, Governor, and Members of the Legislature of the State of California:

I am pleased to submit the State of California’s Comprehensive Annual Financial Report (CAFR) for the fiscal year ended June 30, 2017. This report meets the requirements of Government Code section 12460 for an annual report prepared in accordance with accounting principles generally accepted in the United States and contains information to help readers gain a reasonable understanding of the state’s financial activities.

California’s fiscal health continues to improve since the Great Recession of 2009. For the fiscal year ended June 30, 2017, the state’s revenue exceeded expenses by $9.4 billion for governmental activities, marking the fifth consecutive year the state’s financial position improved. Governmental activities include most expenses normally associated with state government such as health and human services, education, transportation, corrections and rehabilitation programs, and general government administration.

While California’s economy currently is vibrant and its coffers are full, we run the risk of becoming complacent. A fiscal crisis may very well be on our doorstep. Both the 2017-18 State Budget (enacted on June 27, 2017) and the Governor’s proposed 2018-19 budget continue to build the Budget Stabilization Account (the state’s rainy day fund). This emphasis on paying down accumulated debts and liabilities is an effort to counter the potential fiscal impact of federal policy changes on California and the potential end of economic expansion.

I can sum up the Governor’s budgets in one word: smart. The federal tax measure likely will have a devastating impact on our state budget, which may mean less money for essential social services such as Medi-Cal, Medicare, and the children’s health insurance program. It is wise to exercise caution with responsible short-term spending, boost rainy day fund reserves, and pay down debt. In addition, California must create a tax system that is sustainable for our ever-changing economy.

I extend my deep gratitude to all the government agencies for their efforts and support in submitting the required information for this CAFR. Thank you to the California State Auditor and her staff for maintaining the highest standards of professionalism in the management of the state’s finances. Finally, I wish to thank my entire team for their skill, effort, and dedication in completing this financial report.

Sincerely,

Original signed by

BETTY T. YEE

Report Overview

The State’s management assumes responsibility for the accuracy, completeness, and fairness of information presented in the CAFR, including all disclosures, based on a comprehensive framework of internal controls established for this purpose. The internal control structure is designed to provide reasonable, but not absolute, assurance that the financial statements are free of material misstatements. The objective of these controls is to ensure compliance with legal provisions embodied in the annual appropriated budget approved by the Legislature and the Governor.

The California State Auditor has issued an unmodified opinion on the financial statements for the fiscal year ended June 30, 2017, in accordance with auditing standards generally accepted in the United States of America and Government Auditing Standards issued by the Comptroller General of the United States.

The State of California also is required to undergo an annual single audit in conformity with the provisions of the United States Office of Management and Budget’s Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations. That report is issued separately.

The Management’s Discussion and Analysis (MD&A) immediately follows the independent auditor’s report and contains an introduction, overview, and analysis of the financial statements. The MD&A also contains information regarding California’s economy for the fiscal year ended June 30, 2017, and its economic performance as of December 31, 2017, for fiscal year 2017-18. The MD&A complements this transmittal letter and should be read in conjunction with it.

Profile of the State of California

The State of California was admitted to the Union on September 9, 1850. The State’s population, as of 2017, is estimated to be almost 40 million residents. The State’s government is divided into three branches: Executive, Legislative, and Judicial. Executive power is vested in the Governor. Other members of the Executive branch include the Lieutenant Governor, Attorney General, Secretary of State, State Treasurer, State Controller, Insurance Commissioner, and State Superintendent of Public Instruction. All officers of the Executive branch are elected to four-year terms. The Legislative branch of government is the State’s law-making authority and is comprised of two houses: the Senate and the Assembly. The Judicial branch is charged with interpreting the laws of the State. It provides settlement of disputes between parties in controversy, determines the guilt or innocence of those accused of violating laws, and protects the rights of Californians.

California’s government includes control agencies that help to regulate internal governmental operations. The State Controller’s Office, the State’s independent fiscal watchdog, ensures that the State’s budget is spent properly, offers fiscal guidance to local governments, reports on the State’s financial position, and uncovers fraud and abuse of taxpayer dollars. The Department of Finance, part of the Executive branch of government, establishes fiscal policies to carry out the State’s programs and serves as the Governor’s chief fiscal policy adviser. The California State Auditor promotes the efficient and effective management of public funds through independent evaluations of state and local governments.

The State of California provides a wide range of services to its citizens, including social, health, and human services; kindergarten through 12th grade (K-12) and higher education; transportation; business, consumer services, and housing; corrections and rehabilitation programs; and other general government services. The State also is financially accountable for legally separate entities (component units) that provide and support

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post-secondary education programs; provide financing for low and moderate income housing and other public needs; promote agricultural activities; and provide financial assistance to public agencies and small businesses. The State, through its related organizations (organizations for which the primary government is not financially accountable), provides services such as the operation of the statewide energy transmission grid; earthquake insurance for homeowners and renters; workers’compensation insurance; health insurance for individuals, families, and employees of small businesses; financing for pollution control and health facilities; and loans to students attending public and private nonprofit colleges and universities. The financial information of these institutions is not included in the State’s financial statements.

The State Legislature approves an annual budget that contains estimates of revenues and expenditures for the ensuing fiscal year. This budget is the result of negotiations between the Governor and the Legislature. The State Controller’s Office is statutorily responsible for controlling revenues due the primary government and for expenditures of each appropriation contained in the budget. The State’s annual budget is submitted by the Governor no later than January 10 preceding the beginning of the fiscal year on July 1, and must be approved by the Legislature by June 15 each year. This annual budget serves as the foundation for the State’s financial planning and control. Additional information on the budgetary basis of accounting can be found in Note 2, Budgetary and Legal Compliance, in the Budgetary Comparison Schedule at the end of the nonmajor governmental funds combining statements, and in the Required Supplementary Information section of the CAFR that follows the Notes to the Financial Statements.

Overview of the State’s Economy

California’s economy, the largest among the 50 states and one of the largest and most diverse in the world, has major components in high technology, trade, entertainment, manufacturing, government, tourism, construction, and services. The relative proportion of the various components of the California economy closely resembles the make-up of the national economy. California’s gross domestic product totaled $2.7 trillion at fiscal year-end and, as the nation’s leading farm state, had over $46.0 billion in farm production. In 2016, California exported $163.6 billion in products; its two largest export markets are Mexico ($25.2 billion) and Canada ($16.2 billion). California’s six largest exports are computer and electronic products, transportation equipment, machinery except electrical, chemicals, agricultural products, and miscellaneous manufactured commodities. California also enjoys one of the finest and most diverse collections of natural, cultural, and recreational resources in the nation. California’s travel and tourism industry generated revenues of $126.3 billion, and state and local tax revenues of $10.3 billion, in 2016.

Budget Outlook

Fiscal Year 2017-18

Fiscal responsibility continues to be the focus for the 2017 Budget Act. To counter the potential fiscal impact of federal policy changes and the potential end of the current economic expansion, the budget emphasizes building reserves and paying down accumulated debts and liabilities. The January 2018 revised estimates project that fiscal year 2017-18 will end with General Fund revenue and transfers of $127.3 billion, expenditures of $126.5 billion, and total reserves of $12.6 billion—$8.4 billion in the Budget Stabilization Account (BSA) and $4.2 billion in the General Fund’s Special Fund for Economic Uncertainties (SFEU) —which is $3.2 billion more than projected in June 2017 for the enacted budget. In addition to the $1.8 billion minimum annual debt reduction payment required by Proposition 2, the budget also includes a one-time supplemental payment to the California Public Employees’ Retirement System (CalPERS) to help reduce vi

the State’s net pension liability. The payment is funded through internal cash borrowing, and will be repaid by the General Fund and other funds that contribute to CalPERS. The Governor’s additional key priorities in the 2017-18 budget are investing in education, counteracting the effects of poverty, and improving the State’s roads and transportation infrastructure.

Fiscal Year 2018-19

The Governor released his proposed 2018-19 budget on January 10, 2018. Although California has passed seven consecutive on-time budgets, has experienced historic economic expansion, and has consistently kept spending in line with revenues, the Governor continues to focus on building reserves and enhancing California’s fiscal stability. By the end of fiscal year 2018-19, the budget projects total reserves of $15.8 billion—$13.5 billion in the BSA, an amount that the Governor estimates to be the maximum balance allowed by the Constitution, and $2.3 billion in the SFEU. The 2018-19 budget estimates General Fund revenue of $129.8 billion, after a $5.0 billion transfer to the BSA, and expenditures of $131.7 billion.

The 2018-19 budget estimates show increased revenue from personal income taxes, sales and use taxes, and corporation taxes. Personal income taxes contribute the majority of General Fund revenue at 69.4% ($93.6 billion), sales and use taxes contribute 19.4% ($26.2 billion), and corporation taxes contribute 8.3% ($11.2 billion). However, the Governor’s budget estimates were finalized prior to the enactment of the recent federal tax bill; a preliminary analysis of the impact on the State’s economy and revenues will be included in the Governor’s May Revision of the proposed 2018-19 budget.

Long-term Financial Planning

Long-term financial planning initiatives that will impact the State’s long-term financial goals include:

• The 2018-19 Governor’s Budget includes a five-year plan for infrastructure spending. The plan proposes spending $61.3 billion over the next five years, with the vast majority dedicated to the State’s transportation system, including the high-speed rail system. The Road Repair and Accountability Act of 2017, enacted in April 2017, is expected to raise $52.5 billion of additional funding over the next 10 years for repairs and maintenance to the state highway system, and to improve critical transportation routes and corridors. The Governor’s plan also addresses the infrastructure needs of K-12 schools and higher education systems, state parks, and certain state facilities.

• The State has continued to address its significant long-term liabilities associated with state employee pensions and other postemployment benefits (OPEB). In fiscal year 2017-18, the State will make a $6.0 billion supplemental contribution to CalPERS; the first two installments have already been paid and the final installment is expected to occur in April 2018. While the State continues to fund its current OPEB expenses on a “pay-as-you-go” basis, it has begun to prefund its future healthcare benefit costs by depositing agreed-upon employee and state employer contributions in an OPEB trust fund. The Governor estimates that the prefunding plan will eliminate the unfunded OPEB obligation over the next three decades.

• California has historically been susceptible to wildfires and hydrologic variability. Extreme weather, intensified by climate change, has led to essentially a year-round fire season, with larger and more intense fires. In October and December 2017, large wildfires struck the State, destroying thousands of structures and burning over 500,000 acres. The total costs are estimated to be in the billions of dollars, and the full economic impacts will not be realized for years.

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• In December 2017, the federal government enacted the Tax Cuts and Jobs Act, which permanently reduces taxes on corporations, temporarily reduces federal personal income tax rates, and makes significant changes to several mainstay deductions and exclusions. In the coming months, the State will examine how the changes in federal tax law will affect individual Californians, the State’s thriving economy, and its own taxation strategies.

Awards

The Government Finance Officers Association of the United States and Canada (GFOA) awarded a Certificate of Achievement for Excellence in Financial Reporting to the State of California for its comprehensive annual financial report for the fiscal year ended June 30, 2016. In order to be awarded a Certificate of Achievement, a government must publish an easily readable and efficiently organized comprehensive annual financial report. This report must satisfy both generally accepted accounting principles and applicable legal requirements.

A Certificate of Achievement is valid for a period of one year only. We believe that our current comprehensive annual financial report continues to meet the Certificate of Achievement Program’s requirements and we are submitting it to the GFOA to determine its eligibility for another certificate.

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Government Finance Officers Association

Certificate of Achievement for Excellence

in Financial Reporting

Presented to

State of California

For its Comprehensive Annual Financial Report

for the Fiscal Year Ended

June 30, 2016

- p· · ~~. : . ' . .

' .

Executive Director/CEO

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Principal Officials of the State of California

Executive Branch

Edmund G. Brown, Jr. Governor

Gavin Newsom Lieutenant Governor

Betty T. Yee State Controller

Xavier Becerra Attorney General

John Chiang State Treasurer

Alex Padilla Secretary of State

Tom Torlakson Superintendent of Public Instruction

Dave Jones Insurance Commissioner

Board of Equalization George Runner, Member, First District

Fiona Ma, Member, Second District Jerome E. Horton, Member, Third District Diane L. Harkey, Member, Fourth District

Legislative Branch

Toni G. Atkins President pro Tempore, Senate

Anthony Rendon Speaker of the Assembly

Judicial Branch

Tani G. Cantil-Sakauye Chief Justice, State Supreme Court

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California State Controller's Transmittal Letter

Organization Chart of the State of California

Citizens of the State

Legislative

Senate Assembly

Executive

State Controller

State Board of

Equalization

Governor

Insurance Commissioner

Secretary of State

Judicial

Lieutenant Governor

State Supreme Court of

California

State Superintendent

of Public Instruction

Courts of

Appeal

Judicial Council

Commission on Judicial

Performance

State Treasurer

Superior Courts

Attorney General

State Bar of

California

Habeas Corpus

Resource Center

Commission on Judicial

Appointments

Board of Governors Community

Colleges

Trustees of California

State Universities

Office of the Inspector

General

California State

Board of Education

Student Aid Commission

University of California Board of Regents

California Gambling Control

Commission

Delta Stewardship

Council

Arts Council

Public Utilities

Commission

Military Department

Business, Consumer

Services and Housing Agency

Office of Business and

Economic Development

California Lottery

Labor and Workforce

Development Agency

Fair Political Practices

Commission

Department of Finance

State Public

Defender

Natural Resources

Agency

Office of Planning and

Research

Office of Emergency

Services

Government Operations

Agency

Transportation Agency

Health and Human

Services Agency

Department of Corrections

and Rehabilitation

Environmental Protection

Agency

Department of Food and Agriculture

Board of State and

Community Corrections

Department of Veterans

Affairs

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Financial Section

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Independent Auditor’s ReportTHE GOVERNOR AND THE LEGISLATURE OF THE STATE OF CALIFORNIA

Report on the Financial StatementsWe have audited the accompanying financial statements of the governmental activities, the business‑type activities, the aggregate discretely presented component units, each major fund, and the aggregate remaining fund information of the State of California, as of and for the year ended June 30, 2017, and the related notes to the financial statements, which collectively comprise the State of California’s basic financial statements as listed in the table of contents.

Management’s Responsibility for the Financial StatementsManagement is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s ResponsibilityOur responsibility is to express opinions on these financial statements based on our audit. We did not audit the financial statements of the following:

Government-wide Financial Statements

• Certain governmental funds that, in the aggregate, represent five percent of the assets and deferred outflows, and less than one percent of the revenues of the governmental activities.

• Certain enterprise funds that, in the aggregate, represent 82 percent of the assets and deferred outflows, and 53 percent of the revenues of the business‑type activities.

• The University of California and the California Housing Finance Agency that represent 92 percent of the assets and deferred outflows, and 94 percent of the revenues of the discretely presented component units.

Fund Financial Statements

• The Safe Drinking Water State Revolving fund, that represents 12 percent of the assets and deferred outflows of the Environmental and Natural Resources fund, a major governmental fund.

• The following major enterprise funds: Electric Power fund, Water Resources fund, State Lottery fund, and California State University fund.

• The Golden State Tobacco Securitization Corporation, the Public Building Construction, the Public Employees’ Retirement, the State Teachers’ Retirement, the State Water Pollution Control, and the 1943 Veterans Farm and Home Building funds, that represent 84 percent of the assets and deferred outflows, and 51 percent of the additions, revenues and other financing sources of the aggregate remaining fund information.

• The discretely presented component units noted above.

Elaine M. Howle State Auditor

The related financial statements were audited by other auditors whose reports have been furnished to us, and our opinions, insofar as they relate to the amounts included for those funds and entities, are based solely on the reports of the other auditors. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The financial statements of the Golden State Tobacco Securitization Corporation, the Public Building Construction, the State Lottery, and the 1943 Veterans Farm and Home Building funds were not audited in accordance with Government Auditing Standards.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions.

OpinionsIn our opinion, based on our audit and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the respective financial position of the governmental activities, the business‑type activities, the aggregate discretely presented component units, each major fund, and the aggregate remaining fund information of the State of California, as of June 30, 2017, and the respective changes in financial position and, where applicable, cash flows thereof for the year then ended in accordance with accounting principles generally accepted in the United States of America.

Other MattersRequired Supplementary Information

Accounting principles generally accepted in the United States of America require that management’s discussion and analysis, and other required supplementary information as listed in the table of contents, be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We and the other auditors have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management’s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance.

Other InformationOur audit was conducted for the purpose of forming opinions on the financial statements that collectively comprise the State of California’s basic financial statements. The introductory section, combining and individual nonmajor fund financial statements, and statistical section are presented for purposes of additional analysis and are not a required part of the basic financial statements.

The combining and individual nonmajor fund financial statements are the responsibility of management and were derived from and relate directly to the underlying accounting and other records used to prepare the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the basic financial statements or to the basic financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America by us and other auditors. In our opinion, based on our audit, the procedures performed as described above, and the reports of other auditors, the combining and individual nonmajor fund financial statements are fairly stated, in all material respects, in relation to the basic financial statements as a whole.

The introductory and statistical sections have not been subjected to the auditing procedures applied in the audit of the basic financial statements, and accordingly, we do not express an opinion or provide any assurance on them.

Other Reporting Required by Government Auditing StandardsIn accordance with Government Auditing Standards, we have also issued our report dated March 21, 2018 on our consideration of the State of California’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the State of California’s internal control over financial reporting and compliance.

CALIFORNIA STATE AUDITOR

JOHN F. COLLINS II, CPA Deputy State Auditor

March 21, 2018

Management’s Discussion and Analysis

Management’s Discussion and Analysis The following Management’s Discussion and Analysis is required supplementary information to the State of California’s financial statements. It describes and analyzes the financial position of the State, providing an overview of the State’s activities for the fiscal year ended June 30, 2017. We encourage readers to consider the information that we present here in conjunction with the information presented in the Controller’s transmittal letter at the front of this report and in the State’s financial statements and notes, which follow this section.

Financial Highlights – Primary Government

Government-wide Highlights

California’s revenues continue to increase as the economy expands, but with fiscal uncertainty in the future, the administration has curbed discretionary spending and built reserves. For the fiscal year ended June 30, 2017, the State’s general revenues increased by $8.0 billion (5.7%) over the prior year— significantly more than the 1.0% growth experienced in fiscal year 2015-16. Expenses and transfers for the State’s governmental activities increased by $13.2 billion (5.3%) but were less than total revenues received, resulting in a $6.4 billion increase in the governmental activities’net position. Total revenues and transfers for the State’s business-type activities also surpassed expenses by $2.7 billion in fiscal year 2016-17.

Net Position – The primary government ended fiscal year 2016-17 with a net deficit position of $21.3 billion, an improvement of $9.1 billion (29.9%). The total net deficit position is further reduced by $109.3 billion for net investment in capital assets and by $40.1 billion for restricted net position, yielding a negative unrestricted net position of $170.8 billion. Restricted net position is dedicated for specified uses and is not available to fund current activities. More than 69.7%, or $119.1 billion, of the negative $170.8 billion consists of unfunded, employee-related, long-term liabilities that are recognized as soon as an obligation occurs, even though payment will occur over many future periods (net pension liability, net other postemployment benefit obligation, and compensated absences). In addition, the State’s outstanding bonded debt consists of $65.3 billion to build capital assets of school districts and other local governmental entities. Bonded debt reduces the State’s unrestricted net position; however, local governments, not the State, own the capital assets that would normally offset this reduction.

Fund Highlights

Governmental Funds – As of June 30, 2017, the primary government’s governmental funds reported a combined ending fund balance of $37.9 billion, an increase of $7.0 billion over the prior fiscal year. The unrestricted fund balance, comprised of committed, assigned, and unassigned balances, was $4.1 billion, an increase of $2.2 billion over the prior fiscal year’s balance of $1.9 billion. The nonspendable and restricted fund balances were $124 million and $33.7 billion, respectively.

Proprietary Funds – As of June 30, 2017, the primary government’s proprietary funds reported a combined ending net position of $6.7 billion, an increase of $2.5 billion over the prior fiscal year. The total net position is reduced by $2.7 billion for net investment in capital assets, expendable restrictions of $6.5 billion, and nonexpendable restrictions of $2 million, yielding a negative unrestricted net position of $2.5 billion, an improvement of $2.1 billion from the prior fiscal year.

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Noncurrent Assets and Liabilities

As of June 30, 2017, the primary government’s noncurrent assets totaled $160.6 billion, of which $140.7 billion is related to capital assets. State highway infrastructure assets of $75.1 billion represent the largest portion of the State’s capital assets.

The primary government’s noncurrent liabilities totaled $235.3 billion, which consists of $118.9 billion in unfunded employee-related future obligations, $76.0 billion in general obligation bonds, $30.0 billion in revenue bonds, and $10.4 billion in other noncurrent liabilities. During fiscal year 2016-17, the primary government’s noncurrent liabilities increased by $13.8 billion (6.2%) over the previous fiscal year. The most significant changes were increases of $14.3 billion in net pension liability and $3.3 billion in net OPEB obligation, and a decrease of $3.1 billion in loans payable.

Overview of the Financial Statements

This discussion and analysis is an introduction to the section presenting the State’s basic financial statements, which includes four components: (1) government-wide financial statements, (2) fund financial statements, (3) discretely presented component units financial statements, and (4) notes to the financial statements. This report also contains required supplementary information, and combining financial statements and schedules intended to furnish additional detail that supports the basic financial statements.

Government-wide Financial Statements

Government-wide financial statements are designed to provide readers with a broad overview of the State’s finances. The government-wide financial statements do not include fiduciary programs and activities of the primary government and component units because fiduciary resources are not available to support state programs.

The statements provide both short-term and long-term information about the State’s financial position to help readers assess the State’s economic condition at the end of the fiscal year. These statements are prepared using the economic resources measurement focus and the accrual basis of accounting, similar to methods used by most businesses. These statements take into account all revenues and expenses connected with the fiscal year, regardless of when the State received or paid the cash. The government-wide financial statements include two statements: the Statement of Net Position and the Statement of Activities.

• The Statement of Net Position presents all of the State’s financial and capital resources in a format in which assets and deferred outflows of resources equal liabilities and deferred inflows of resources, plus net position. Over time, increases or decreases in net position indicate whether the financial position of the State is improving or deteriorating.

• The Statement of Activities presents information showing how the State’s net position changed during the most recent fiscal year. The State reports changes in net position as soon as the event giving rise to the change occurs, regardless of the timing of the related cash flows. Thus, this statement reports revenues and expenses for some items that will result in cash flows in future fiscal periods (e.g., uncollected taxes and earned but unused vacation leave). This statement also presents a comparison between direct expenses and program revenues for each function of the State.

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The government-wide financial statements separate into different columns the three types of state programs and activities—governmental activities, business-type activities, and component units.

• Governmental activities are mostly supported by taxes, such as personal income and sales and use taxes, and intergovernmental revenues, primarily federal grants. Most services and expenses normally associated with state government fall into this activity category, including general government; education (public K–12 schools and institutions of higher education); health and human services; natural resources and environmental protection; business, consumer services, and housing; transportation; corrections and rehabilitation; and interest on long-term debt.

• Business-type activities typically recover all or a significant portion of their costs through user fees and charges to external users of goods and services. The business-type activities of the State of California include providing unemployment insurance programs, providing housing loans to California veterans, providing water to local water districts, providing services to California State University students, selling California State Lottery tickets, and selling electric power. These activities are conducted with minimal financial assistance from the governmental activities or general revenues of the State.

• Component units are organizations that are legally separate from the State, but for which the State is financially accountable, or whose relationship with the State is so significant that their exclusion would cause the State’s financial statements to be misleading or incomplete. Various types of component units are presented; all are legally separate. However, blended component units function as part of the State’s operations. Fiduciary component units are primarily the resources and operations of the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System. Discretely presented component units contain some form of accountability either from or to the State.

Most component units prepare their own separately issued financial statements. For information regarding obtaining the financial statements of the individual component units, refer to Note 1A, Reporting Entity.

Fund Financial Statements

The State of California, like other state and local governments, uses fund accounting to ensure and demonstrate compliance with finance-related legal and contractual requirements. A fund is a grouping of related accounts that is used to maintain control over resources that have been segregated for specific activities or objectives. All of the funds of the State may be divided into three categories: governmental funds, proprietary funds, and fiduciary funds.

• Governmental funds are used to account for essentially the same functions that are reported as governmental activities in the government-wide financial statements. However, unlike the government-wide financial statements, governmental fund financial statements focus on short-term inflows and outflows of spendable resources, as well as on balances of spendable resources available at the end of the fiscal year. Such information may be useful in evaluating a government’s short-term financing requirements. This approach is known as the flow of current financial resources measurement focus and the modified accrual basis of accounting. These governmental fund statements provide a detailed short-term view of the State’s finances, enabling readers to determine whether adequate financial resources exist to meet the State’s current needs.

7


Because governmental fund financial statements provide a narrower focus than do government-wide financial statements, it is useful to compare the information presented for governmental funds with similar information presented for governmental activities in the government-wide financial statements. By doing so, readers may better understand the long-term impact of the government’s short-term financing decisions. Both the governmental fund balance sheet and the governmental fund statement of revenues, expenditures, and changes in fund balances provide a reconciliation to facilitate comparison between governmental funds and governmental activities. Primary differences between the government-wide and fund-based statements relate to noncurrent assets, such as land and buildings, and noncurrent liabilities, such as bonded debt and amounts owed for net pension liability, compensated absences, and capital lease obligations. These amounts are reported in the government-wide statements but not in the fund-based statements.

• Proprietary funds show activities that operate more like those found in the private sector. The State of California has two proprietary fund types—enterprise funds and internal service funds.

Enterprise funds record activities for which a fee is charged to external users; they are presented as business-type activities in the government-wide financial statements.

Internal service funds accumulate and allocate costs internally among the State’s various functions. For example, internal service funds provide public buildings construction, information technology, printing, fleet management, and architectural services primarily for state departments. As a result, their activity is considered governmental.

• Fiduciary funds account for resources held for the benefit of parties outside the State. Fiduciary funds and the activities of fiduciary component units are not reflected in the government-wide financial statements because the resources of these funds are not available to support state programs. The accounting used for fiduciary funds and similar component units is similar to that used for trusts.

Discretely Presented Component Units Financial Statements

The State has financial accountability for discretely presented component units, which have certain independent qualities and operate in a similar manner to private sector businesses. The activities of the discretely presented component units are classified as enterprise activities.

Notes to the Financial Statements

The notes to the financial statements in this publication provide additional information that is essential for a full understanding of the data provided in the government-wide and fund financial statements. The notes to the financial statements, which describe particular accounts in more detail, immediately follow the discretely presented component units financial statements.

Required Supplementary Information

A section of required supplementary information follows the notes to the basic financial statements in this publication. This section includes several schedules of information for the State’s pension plans and the State’s contributions to those plans; a schedule of funding progress for OPEB trust funds; information on infrastructure assets based on the modified approach; a budgetary comparison schedule; and a reconciliation of the budgetary basis and the GAAP basis fund balances for the major governmental funds presented in the governmental fund financial statements. 8


Combining Financial Statements and Schedules

The Combining Financial Statements and Schedules – Nonmajor and Other Funds section presents combining statements that provide separate financial statements for nonmajor governmental funds, nonmajor proprietary funds, fiduciary funds, and nonmajor component units as supplementary information. The basic financial statements present only summary information for these activities.

Government-wide Financial Analysis

Net Position

The primary government’s combined net position (governmental and business-type activities) increased by $9.1 billion (29.9%) from a negative $30.4 billion to a negative $21.3 billion at June 30, 2017.

The primary government’s $109.3 billion net investment in capital assets, such as land, buildings, equipment, and infrastructure (roads, bridges, and other immovable assets) comprise a significant portion of its net position. This amount of capital assets is net of any outstanding debt used to acquire those assets. The State uses capital assets when providing services to citizens; consequently, these assets are not available for future spending. Although the State’s investment in capital assets is reported net of related debt, the resources needed to repay this debt must come from other sources because the State cannot use the capital assets to pay off the liabilities.

Another $40.1 billion of the primary government’s net position represents resources that are externally restricted as to how they may be used, such as resources pledged to debt service. The internally-imposed earmarking of resources is not presented in this publication as restricted net position. As of June 30, 2017, the primary government’s combined unrestricted net deficit position was $170.8 billion—$169.5 billion for governmental activities and $1.3 billion for business-type activities.

A significant factor contributing to the unrestricted net deficit is that governments recognize a liability on the government-wide Statement of Net Position as soon as an obligation occurs, while financing and budgeting functions focus on when a liability will be paid. As of June 30, 2017, the primary government recognized $119.1 billion (69.7% of the $170.8 billion unrestricted net deficit) in unfunded employee-related obligations—net pension liability, net other postemployment benefits obligation, and compensated absences. In addition, the primary government recognized $65.3 billion in outstanding bonded debt issued to build capital assets for school districts and other local governmental entities, a common state practice nationwide. As the State does not own these capital assets, neither the assets nor the related bonded debt is included in the portion of net position reported as net investment in capital assets. Instead, the bonded debt is reported as a noncurrent liability that increases the State’s unrestricted net deficit position. The State can expect continued deficits in the unrestricted net position of governmental activities as long as it has significant unfunded employee-related obligations and outstanding obligations for school districts and other local governmental entities.

9


Table 1 presents condensed financial information derived from the Statement of Net Position for the primary government.

Table 1

Net Position – Primary Government – Two-year Comparison June 30, 2017 and 2016 (amounts in millions)

Governmental Activities Business-type Activities Total 2017 2016 2017 2016 2017 2016

ASSETS Current and other assets............................... $ 84,127 $ 78,452 $ 25,972 $ 25,226 $ 110,099 $ 103,678 Capital assets ............................................... 129,996 126,859 10,670 9,849 140,666 136,708

Total assets .............................................. 214,123 205,311 36,642 35,075 250,765 240,386 DEFERRED OUTFLOWS OF RESOURCES 17,173 7,726 2,350 1,328 19,523 9,054

Total assets and deferred outflows of resources .......................... $ 231,296 $ 213,037 $ 38,992 $ 36,403 $ 270,288 $ 249,440

LIABILITIES Noncurrent liabilities ................................... $ 209,370 $ 194,826 $ 25,888 $ 26,618 $ 235,258 $ 221,444 Other liabilities ............................................ 47,837 47,847 4,700 4,127 52,537 51,974

Total liabilities ........................................ 257,207 242,673 30,588 30,745 287,795 273,418 DEFERRED INFLOWS OF RESOURCES 2,714 5,249 1,121 1,085 3,835 6,334

Total liabilities and deferred inflows of resources............................. 259,921 247,922 31,709 31,830 291,630 279,752

NET POSITION Net investment in capital assets................... 107,042 104,597 2,295 2,521 109,337 107,118 Restricted ..................................................... 33,832 29,061 6,309 5,759 40,141 34,820 Unrestricted.................................................. (169,499) (168,543) (1,321) (3,707) (170,820) (172,250)

Total net position (deficit)...................... (28,625) (34,885) 7,283 4,573 (21,342) (30,312) Total liabilities, deferred inflows of resources, and net position ............ $ 231,296 $ 213,037 $ 38,992 $ 36,403 $ 270,288 $ 249,440

Note: Prior-year adjustments recorded in the current year have not been reflected in the prior-year column.

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Chart 1 presents a two-year comparison of the State’s net position.

Chart 1

Net Position – Primary Government – Two-year Comparison June 30, 2017 and 2016 (amounts in billions)

Note: Prior-year adjustments recorded in the current year have not been reflected in the 2016 amounts.

Changes in Net Position

The expenses of the primary government totaled $287.1 billion for the fiscal year ended June 30, 2017. Of this amount, $147.7 billion (49.9%) was funded with program revenues (charges for services or program-specific grants and contributions), leaving $139.4 billion to be funded with general revenues (mainly taxes). The primary government’s general revenues of $148.5 billion exceeded net unfunded expenses by $9.1 billion, resulting in a 29.9% increase in net position.

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Table 2 presents condensed financial information derived from the Statement of Activities for the primary government.

Table 2

Changes in Net Position – Primary Government – Two-year Comparison Years ended June 30, 2017 and 2016 (amounts in millions)

Governmental Activities Business-type Activities Total 2017 2016 2017 2016 2017 2016

REVENUES Program Revenues:

Charges for services ................................... $ 27,011 $ 27,422 $ 26,265 $ 25,427 $ 53,276 $ 52,849 Operating grants and contributions ............ 89,497 86,629 1,805 1,765 91,302 88,394 Capital grants and contributions................. 3,028 1,480 61 67 3,089 1,547

General Revenues: Taxes........................................................... 148,021 140,028 — — 148,021 140,028 Investment and interest............................... 149 132 — — 149 132 Miscellaneous............................................. 326 305 — — 326 305

Total revenues........................................ 268,032 255,996 28,131 27,259 296,163 283,255 EXPENSES Program Expenses:

General government ................................... 17,400 16,686 — — 17,400 16,686 Education.................................................... 67,378 65,468 — — 67,378 65,468 Health and human services......................... 135,090 127,543 — — 135,090 127,543 Natural resources and environmental

protection ................................................ 7,342 6,988 — — 7,342 6,988 Business, consumer services, and

housing.................................................... 1,164 815 — — 1,164 815 Transportation............................................. 12,947 12,121 — — 12,947 12,121 Corrections and rehabilitation .................... 13,087 11,875 — — 13,087 11,875 Interest on long-term debt .......................... 4,191 4,232 — — 4,191 4,232 Electric Power ............................................ — — 945 728 945 728 Water Resources......................................... — — 1,223 1,087 1,223 1,087 State Lottery ............................................... — — 6,272 6,316 6,272 6,316 Unemployment Programs........................... — — 11,908 11,459 11,908 11,459 California State University......................... — — 8,001 7,199 8,001 7,199 Other enterprise programs .......................... — — 155 151 155 151

Total expenses........................................ 258,599 245,728 28,504 26,940 287,103 272,668 Excess (deficiency) before transfers .... 9,433 10,268 (373) 319 9,060 10,587

Gain on early extinguishment of debt ........ 31 41 –– –– 31 41 Transfers ..................................................... (3,083) (2,800) 3,083 2,800 –– –– Change in net position................................ 6,381 7,509 2,710 3,119 9,091 10,628

Net position, beginning ................................ (35,006)* (42,394)* 4,573 1,454 (30,433) (40,940) Net position (deficit), ending ....................... $ (28,625) $ (34,885) $ 7,283 $ 4,573 $ (21,342) $ (30,312) *Restated


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Governmental Activities

During fiscal year 2016-17, governmental activities’expenses and transfers totaled $261.6 billion. Program revenues totaling $119.5 billion, including $92.5 billion received in federal grants and contributions, funded 45.7% of expenses and transfers, leaving $142.1 billion to be funded with general revenues (mainly taxes). General revenues for governmental activities ($148.5 billion) exceeded net unfunded expenses and transfers, resulting in the governmental activities’ net deficit position of $28.6 billion for the fiscal year ended June 30, 2017, an improvement of $6.4 billion (18.2%) from the prior year’s net deficit position of $35.0 billion.

Chart 2 presents a comparison of governmental activities’ expenses to related revenue by program.

Chart 2

Program Revenues and Expenses – Governmental Activities Year ended June 30, 2017 (amounts in billions)

For the fiscal year ended June 30, 2017, total governmental activities’ revenue was $268.0 billion, an increase of 4.7% over the prior year. General revenues increased by $8.0 billion (5.7%) to $148.5 billion, and program revenues increased by $4.0 billion (3.5%) to $119.5 billion. Personal income taxes increased by $5.4 billion over the prior year primarily due to increased capital gains from a strong stock market, representing a 6.7% increase compared to the fiscal year 2015-16 increase of 2.8%. Corporation taxes increased by $1.9 billion (20.8%) from the prior year, primarily due to the resolution of several multi-year taxpayer audits.

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Overall expenses for governmental activities increased by $12.9 billion (5.2%) over the prior year. The largest increase in expenditures, $7.5 billion (5.9%), occurred in health and human services programs; the majority of the increase is attributable to the Department of Health Care Services, which administers the State’s Medi-Cal program. Another significant increase of $1.9 billion (2.9%) was for education as a result of the Proposition 98 minimum funding guarantee; the increased spending was triggered by higher General Fund revenue.

Chart 3 presents the percentage of total expenses for each governmental activities program.

Chart 3

Expenses by Program Year ended June 30, 2017 (as a percent)

Chart 4 presents the percentage of total revenues by source for each governmental activities program.

Chart 4

Revenues by Source Year ended June 30, 2017 (as a percent)

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Business-type Activities

As of June 30, 2017, business-type activities’ expenses totaled $28.5 billion. Program revenues of $28.1 billion, primarily generated from charges for services, and $3.1 billion in transfers, were sufficient to cover these expenses. As a result, the business-type activities’ total net position of $7.3 billion increased by $2.7 billion (59.3%) over the prior year’s net position of $4.6 billion.

Chart 5 presents a two-year comparison of the expenses of the State’s business-type activities.

Chart 5

Expenses – Business-type Activities – Two-year Comparison Years ended June 30, 2017 and 2016 (amounts in billions)

Fund Financial Analysis

The financial position of the State’s governmental funds continued to improve in fiscal year 2016-17, with a combined fund balance of $7.0 billion over the prior year’s ending fund balance. Governmental funds rely heavily on taxes to support the majority of the State’s services and programs; both personal income and corporation taxes increased during the fiscal year. Proprietary funds’ net position increased by $2.5 billion during fiscal year 2016-17—$2.7 billion increase in enterprise funds and $264 million decrease in internal service funds. The majority of the increase in the enterprise funds’ net position was in the Unemployment Programs Fund, increasing its fund balance to $4.1 billion, which was caused by the State’s declining unemployment rate.

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Governmental Funds

As of June 30, 2017, the governmental funds’ Balance Sheet reported $89.6 billion in assets, $51.7 billion in liabilities and deferred inflows of resources, and $37.9 billion in fund balance. Total assets of governmental funds increased by 8.9%, while total liabilities and deferred inflows of resources increased by 0.7%, resulting in a total fund balance increase of $7.0 billion (22.8%) over the prior year’s balance.

Within the governmental funds’ total fund balance, $124 million is classified as nonspendable, as this amount consists of long-term interfund receivables, loans receivable, and legal or contractual requirements. Additionally, $33.7 billion is classified as restricted for specific programs by external constraints such as debt covenants and contractual obligations, or by constitutional provisions or enabling legislation. Furthermore, of the total fund balance, $6.0 billion is classified as committed for specific purposes and $12 million is classified as assigned for specific purposes. The remaining unassigned balance of the governmental funds is a negative $1.9 billion, an improvement of $1.9 billion from the prior fiscal year.

The Statement of Revenues, Expenditures, and Changes in Fund Balances of the governmental funds reported $267.8 billion in revenues, $268.5 billion in expenditures, and a net $7.7 billion in receipts from other financing sources. The ending fund balance of the governmental funds for the fiscal year ended June 30, 2017, was $37.9 billion, a $7.0 billion increase over the prior year’s ending fund balance of $30.9 billion.

Governmental funds’ revenue consists primarily of taxes (55.3%) and intergovernmental revenue (35.7%). Personal income taxes accounted for 57.9% of tax revenues and increased by $5.8 billion over the prior fiscal year. Sales and use taxes accounted for 26.2% of tax revenues and decreased by $394 million from the prior fiscal year. Corporation taxes accounted for 7.5% of tax revenues and increased by $1.9 billion over the prior fiscal year. Intergovernmental revenue, primarily from the federal government, increased by $4.6 billion (5.1%) over the prior fiscal year.

Governmental funds’ expenditures increased by $13.3 billion (5.2%) over the prior fiscal year, primarily for health and human services, bond and commercial paper retirement, and education. The increase in health and human services expenditures of $7.2 billion (5.6%), is due primarily to increased costs associated with the in-home supportive services program, one-time payment of prescription drug rebates budgeted but not paid in the prior fiscal year, and increased Medi-Cal caseload under the Patient Protection and Affordable Care Act (federal health care reform). The $2.4 billion increase in bond and commercial paper retirement expenditures resulted from additional principal repayments from the current refunding of various general obligation bonds for future debt service savings. The $2.0 billion increase in education expenditures is to comply with constitutional requirements (Proposition 98) that provide a minimum funding guarantee to support California’s K-12 schools and community colleges; the minimum funding guarantee increased as a result of increased General Fund revenue in fiscal year 2016-17.

16


Chart 6 presents a two-year comparison of governmental funds’ tax revenues.

Chart 6

Governmental Funds Tax Revenue – Two-year Comparison Years ended June 30, 2017 and 2016 (amounts in billions)

* New tax effective on July 1, 2016.

17


Chart 7 presents a two-year comparison of the components of the governmental funds’ balance.

Chart 7

Governmental Funds – Components of Fund Balance – Two-year Comparison Years ended June 30, 2017 and 2016 (amounts in billions)

Note: Assigned fund balance was $12 million, which rounds to zero when presented in billions.

The State’s major governmental funds are the General Fund, the Federal Fund, the Transportation Fund, and the Environmental and Natural Resources Fund. The General Fund ended the fiscal year with a fund balance of $5.8 billion, an increase of $5.4 billion over the prior year’s fund balance. The Federal Fund, the Transportation Fund, and the Environmental and Natural Resources Fund ended the fiscal year with fund balances of $228 million, $9.1 billion, and $10.7 billion, respectively. The nonmajor governmental funds ended the fiscal year with a total fund balance of $12.1 billion.

General Fund: As shown on the Balance Sheet, the General Fund (the State’s main operating fund) ended fiscal year 2016-17 with assets of $26.4 billion; liabilities and deferred inflows of resources of $20.6 billion; and nonspendable, restricted, and committed fund balances of $104 million, $7.4 billion, and $181 million, respectively, leaving the General Fund with a negative unassigned fund balance of $1.9 billion. Total assets of the General Fund increased by $5.4 billion (26.0%) over the prior fiscal year, while total liabilities and deferred inflows of resources decreased by $11 million (0.1%). The General Fund’s unassigned fund balance deficit decreased by $1.9 billion (50.2%).

As shown on the Statement of Revenue, Expenditures, and Changes in Fund Balances, the General Fund had an excess of revenues over expenditures of $8.9 billion ($125.1 billion in revenues and $116.2 billion in expenditures). Approximately $120.3 billion (96.1%) of General Fund revenue is derived from the State’s largest three taxes—personal income taxes ($84.3 billion), sales and use taxes ($24.9 billion), and corporation taxes ($11.1 billion). As a result of fund classifications made to comply with generally accepted governmental accounting principles, a total of $309 million in revenue, essentially all from unemployment programs, is included in the General Fund. These revenues are not considered General Fund revenues for any budgetary purposes or for the State’s Budgetary/Legal Basis Annual Report.

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During fiscal year 2016-17, total General Fund revenue increased by $7.5 billion (6.4%). The increase is a result of increases in personal income taxes of $5.7 billion (7.3%) and in corporation taxes of $1.9 billion (20.7%). General Fund expenditures increased by $4.5 billion (4.0%). The largest increases were in education and health and human services expenditures, which were up $2.0 billion and $1.3 billion, respectively. The General Fund ended the fiscal year with a fund balance of $5.8 billion, an improvement of $5.4 billion from the prior year’s ending fund balance of $362 million.

Federal Fund: The Federal Fund reports federal grant revenues and the related expenditures to support grant programs. The largest of these programs is for health and human services, which accounted for $77.4 billion (84.3%) of the total $91.8 billion in fund expenditures. The Medical Assistance program and the Temporary Assistance for Needy Families program are included in this program area. Education and transportation programs also constituted a large part of the fund’s expenditures, amounting to $7.4 billion (8.1%) and $5.6 billion (6.1%) of the total, respectively. The Federal Fund’s revenues increased by $4.4 billion, which was approximately the same amount of increase in the combined expenditures and transfers, resulting in a $20 million fund balance decrease from the prior year’s ending fund balance of $248 million, to $228 million.

Transportation Fund: The Transportation Fund accounts for fuel taxes, bond proceeds, and other revenues used primarily for highway and passenger rail construction. The Transportation Fund’s revenues decreased by $82 million (0.8%), while its expenditures decreased by $288 million (2.6%). Other financing sources provided net receipts of $1.3 billion. The Transportation Fund ended the fiscal year with a $9.1 billion fund balance, an increase of $549 million over the prior year.

Environmental and Natural Resources Fund: The Environmental and Natural Resources Fund accounts for fees, bond proceeds, and other revenues that are used for maintaining the State’s natural resources and improving the environmental quality of its air, land, and water. The Environmental and Natural Resources Fund’s revenues decreased by $830 million (15.1%), while its expenditures increased by $1.3 billion (25.8%). Other financing sources provided net receipts of $2.1 billion, mainly from bond proceeds. The Environmental and Natural Resources Fund ended the fiscal year with a $10.7 billion fund balance, an increase of $541 million (5.3%) over the prior year.

Proprietary Funds

Enterprise Funds: The total net position of the enterprise funds at June 30, 2017, was $7.3 billion— $2.7 billion greater than the prior year’s net position of $4.6 billion. The Unemployment Programs Fund had an increase in net position of $2.5 billion to end the fiscal year with a balance of $4.1 billion. The California State University Fund and the nonmajor enterprise funds increased their net positions by $112 million and $128 million, respectively; while the State Lottery Fund decreased its net position by $59 million.

As shown on the proprietary funds’Statement of Net Position, total assets and deferred outflows of resources for the enterprise funds were $39.6 billion as of June 30, 2017. Of this amount, current assets totaled $13.5 billion, noncurrent assets totaled $23.8 billion, and deferred outflows of resources totaled $2.3 billion. The total liabilities and deferred inflows of resources for the enterprise funds was $32.3 billion. The two largest liabilities of the enterprise funds are $15.0 billion in revenue bonds payable and $8.8 billion in net pension liability. During fiscal year 2016-17, the State reduced by $2.7 billion the balance of the loans from the U.S. Department of Labor that covered prior-year deficits in the Unemployment Programs Fund, leaving a $385 million balance expected to be paid in fiscal year 2017-18.

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Total net position consisted of four segments: net investment in capital assets of $2.3 billion, nonexpendable restricted net position of $2 million, restricted expendable net position of $6.3 billion, and unrestricted net deficit of $1.3 billion.

As shown on the Statement of Revenues, Expenses, and Changes in Fund Net Position of proprietary funds, the enterprise funds ended the year with operating revenues of $25.1 billion, operating expenses of $25.6 billion, and net revenues from other transactions of $78 million. The largest sources of operating revenue were unemployment and disability insurance receipts of $14.4 billion in the Unemployment Programs Fund, and lottery ticket sales of $6.2 billion collected by the State Lottery Fund. The largest operating expenses were distributions of $11.6 billion to beneficiaries by the Unemployment Programs Fund, personal services of $5.2 billion by the California State University Fund, and lottery prizes of $4.0 billion distributed by the State Lottery Fund.

Internal Service Funds: The total net deficit of the internal service funds was $632 million as of June 30, 2017. The net position consists of three segments: net investment in capital assets of $432 million, restricted expendable net position of $169 million, and unrestricted net deficit of $1.2 billion.

Fiduciary Funds

The State of California has four types of fiduciary funds: private purpose trust funds, pension and other employee benefit trust funds, investment trust funds, and agency funds. The private purpose trust funds ended the fiscal year with a net position of $7.9 billion. The pension and other employee benefit trust funds ended the fiscal year with a net position of $560.2 billion. The State’s only investment trust fund, the Local Agency Investment Fund, ended the fiscal year with a net position of $22.8 billion. Agency funds act as clearing accounts and thus do not have a net position.

For the fiscal year ended June 30, 2017, the fiduciary funds’ combined net position was $590.9 billion, a $53.8 billion increase over the prior year net position. The net position increase is attributed to a $57.1 billion increase in net investment income over the prior fiscal year in pension and other employee benefit trust funds.

General Fund Budget Highlights

The original General Fund budget of $121.0 billion was increased by $2.0 billion during fiscal year 2016-17. This increase is mainly composed of funding for health and human services. The funding for health and human services increased primarily due to Medi-Cal cost inflation, caseload growth, and program expansion. Beginning in January 2017, the State assumed a 5.0% share of the optional expansion cost previously fully paid by the federal government. During fiscal year 2016-17, the General Fund’s actual budgetary basis expenditures were $119.9 billion, $3.1 billion less than the final budgeted amount of $123.0 billion.

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Table 3 presents a summary of the General Fund original and final budgets.

Table 3

General Fund Original and Final Budgets Year ended June 30, 2017 (amounts in millions)

Original Final Increase/

(Decrease) Budgeted amounts

Business, consumer services, and housing .................................................. $ Transportation.............................................................................................. Natural resources and environmental protection ......................................... Health and human services ..........................................................................

77 4

1,886 33,512

$ 78 4

2,033 34,826

$ 1 —

147 1,314

Corrections and rehabilitation...................................................................... 10,589 10,997 408 Education ..................................................................................................... General government:

Tax relief ...................................................................................................

62,305

467

62,303

467

(2)

— Debt service............................................................................................... 5,415 5,415 — Other general government.........................................................................

Total ....................................................................................................... $ 6,741

120,996 $ 6,845

122,968 $ 104

1,972

Capital Assets and Debt Administration

Capital Assets

As of June 30, 2017, the State’s investment in capital assets for its governmental and business-type activities amounted to $140.7 billion (net of accumulated depreciation/amortization). The State’s capital assets include land, state highway infrastructure, collections, buildings and other depreciable property, intangible assets, and construction/development in progress. The buildings and other depreciable property account includes buildings, improvements other than buildings, equipment, certain infrastructure assets, certain books, and other capitalized and depreciable property. Intangible assets include computer software, land use rights, patents, copyrights, and trademarks. Infrastructure assets are items that normally are immovable, such as roads and bridges, and can be preserved for a greater number of years than can most capital assets.

As of June 30, 2017, the State’s capital assets increased $4.0 billion, or 2.9% over the prior fiscal year. The majority of the increase occurred in state highway infrastructure, and buildings and other depreciable property.

Additional information on the State’s capital assets can be found in Note 7.

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Table 4 presents a summary of the primary government’s capital assets for governmental and business-type activities.

Table 4

Capital Assets – Primary Government – Two-year Comparison June 30, 2017 and 2016 (amounts in millions)

Governmental Activities Business-type Activities 2017 2016 2017 2016

Land ............................................................... $ 19,716 $ 19,383 $ 258 $ 245 State highway infrastructure .......................... 75,071 73,463 — — Collections – nondepreciable......................... 23 23 22 16 Buildings and other

depreciable property ................................... 31,115 29,616 13,718 12,743 Intangible assets – amortizable ...................... 2,076 2,032 421 336 Less: accumulated

depreciation/amortization........................... (14,304) (13,400) (5,616) (5,244) Construction/development in progress .......... 15,871 15,316 1,750 1,639 Intangible assets – nonamortizable ................ 428 426 117 114

Total........................................................ $ 129,996 $ 126,859 $ 10,670 $ 9,849


$

$

Total 2017

19,974 $ 75,071

45

44,833 2,497

(19,920) 17,621

545 140,666 $

2016

19,628 73,463

39

42,359 2,368

(18,644) 16,955

540 136,708

Modified Approach for Infrastructure Assets

The State has elected to use the modified approach for capitalizing infrastructure assets of the state highway system (state roadways and bridges). Under the modified approach, the State does not report depreciation expense for its roads and bridges but capitalizes all costs that add to their capacity and efficiency. All maintenance and preservation costs are expensed. Under the modified approach, the State maintains an asset management system to demonstrate that the infrastructure is preserved at or above established condition levels. During fiscal year 2016-17, the actual amount spent on preservation was 53.2% of the estimated budgeted amount needed to maintain the infrastructure assets at established condition levels. Although the amount spent fell short of the budgeted amount, the assessed condition of the State’s bridges and roadways is better than the established condition baselines, with 96.6% of bridge deck area judged to be of fair or better quality and 84.1% of lane miles judged to be of fair or better quality in the last completed pavement-condition survey. The State is responsible for maintaining 49,645 lane miles and 12,976 bridges.

The Required Supplementary Information includes additional information on how the State uses the modified approach for infrastructure assets; it also presents the established condition standards, condition assessments, and preservation costs.

Debt Administration

At June 30, 2017, the State had total bonded debt outstanding of $111.3 billion. Of this amount, $79.5 billion (71.4%) represents general obligation bonds, which are backed by the full faith and credit of the State. The current portion of general obligation bonds outstanding is $3.5 billion and the long-term portion is

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$76.0 billion. The remaining $31.8 billion (28.6%) of bonded debt outstanding represents revenue bonds, which are secured solely by specified revenue sources. The current portion of revenue bonds outstanding is $1.9 billion and the long-term portion is $29.9 billion.

During the fiscal year, the State issued $9.0 billion in new general obligation bonds to fund various capital projects and other voter-approved costs related to K-12 schools and higher education facilities, transportation improvements and high-speed rail, water quality and environmental protection, and other public purposes.

Table 5 presents a summary of all the primary government’s long-term obligations for governmental and business-type activities.

Table 5

Long-term Obligations – Primary Government – Two-year Comparison Years ended June 30, 2017 and 2016 (amounts in millions)

Governmental Activities Business-type Activities 2017 2016 2017 2016

Government-wide noncurrent liabilities General obligation bonds ................................. $ 75,329 $ 75,854 $ 667 $ 736 Revenue bonds payable.................................... 16,088 16,530 13,869 12,905

Total bonded debt ......................................... 91,417 92,384 14,536 13,641 Net pension liability/obli

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